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this video covers accounting for restructuring activities and i'll teach you the accounting rule i'll show you an example of restructuring done at gopro a public company and i'll also show you one piece of academic research on restructuring that as i find interesting but first believe it or not what i'm going to do is read from the textbook to help you understand what restructuring activities are and why they give rise to costs so i'm starting on page 622 it's not uncommon for a company to face corporate challenges that are so great that the only way forward is to alter the organizational operational and financial structures such corporate restructurings are designed to turn a company around and are frequently initiated in response to poor performance mounting debt and shareholder pressure a restructuring can involve eliminating business segments selling major assets downsizing the workforce and reconfiguring debt ultimately the goal of a restructuring is to positively impact a company's long-term financial performance but in the short term restructurings usually have a large negative impact on the company's financial statements the income statement specifically so let me just tell you the rule for restructuring costs when a company one of management decides that they're going to restructure lay people off sell assets terminate contracts they need to make a plan and they need to price the plan so what's this plan going to cost us then they present the plan to the board of directors and the board of directors approves the restructuring plan they say go ahead and do it well as soon as the board approves the restructuring plan the company records an expense right away for the expected costs of the restructuring so they'll debit an expense account and credit a restructuring liability and that is recorded right away investors need to know right away what is the cost of this restructuring activities and it all comes onto the income statement right at the inception of the restructuring plan now as they pay off the liabilities they're crediting cash and debiting the liability paying it off there can also be subsequent adjustments to the liability because the plan that they priced originally could be wrong i mean you know they might need to change the amount of the liability if certain restructuring activities cost more or less than what they expected and that's basically how a company accounts for restructuring activities so now let's go through grow pros uh restructuring disclosures and we'll talk about their journal entries and how they accounted for them so let me just get out of the way a little bit here so let me read this to you fourth quarter 2016 restructuring at gopro so gopro had a bit of a bad year in 2016 and they were a little uh they had uh some problems and so they decided to risk structure and here's what they said on november 29 2016 the company approved and when they say the company the board of directors approved a restructuring plan to reduce future operating expenses so they're going to trim the business and the operating expenses in the future are going to be lower that's the plan the restructuring provided for a reduction of the company's global workforce of approximately 15 percent so ouch that uh 15 is layoffs of 50 15 of their workforce so unfortunately quite a lot of gopro employees were laid off in this restructuring it also had to do with the closure of the company's entertainment group to concentrate on its core business and it also had to do with the consolidation of certain leased office facilities so they're trimming the business they're focusing the business on what they say they're good at you know gopro when when they when gopro ipo'd they kind of tried to make themselves it was kind of during the social media craze and social media companies had very high valuations like social media companies with low amounts of revenue could achieve high valuations in the stock market and i think what gopro did is they kind of got caught up in that whole social media idea and they initially tried to brand themselves as a social media company like you're going to take gopro video but the mate you're going to share it on the gopro website and stuff like that and i don't think it really went over all that well you know i don't think they went over it all that well as a social media company so here they are restructuring the entertainment group to focus on the core business what is the core business of a gopro well they make cameras that you take with you when you go snowboarding or or whatever so that's what they're good at and they're going to focus on that but it involves laying people off selling some assets and consolidating some office space okay so the follow here it says the following table is a summary of the company's restructuring activities during 2017 and related liabilities recorded in accrued liabilities on the consolidated balance sheet and they've got they break it out severance activities so laying people off and then other activities and then they have a total column here so the restructuring liability as of december 31st 2016 was 10 539 then they had new restructuring charges during 2017 so they had to add to the liability of 3189 and they paid off some of their obligations 13 295 they paid off some of those obligations then they have 17 of who knows what i don't even know what that relates to non-cash reductions and then so this is basically the restructuring liability t account okay it's got a beginning credit balance of 10 539 it had a credit to the account of 3189 a debit to the account of 13 295 and a credit to the account of 17 and it had an ending balance of 450. so that's the t account for the year of gopro's restructuring a liability account now let me just show you some of how these journal entries would look so uh let's just assume that in 2016 the company went uh the management went to the board with a restructuring plan and let's just assume that the restructuring plan was 10 539 okay that let's just assume that's the initial amount of the liability that they recorded now in truthfulness this is the liability of december 31 2016. so it could have been higher than this and then they just paid some of it off already but we're going to assume that they went to the board with a plan hey we're going to spend 10.5 million dollars and we're going to restructure the business so the board approved it what happens when the board approved it okay well in 2016 here's the journal entry that would happen immediately a debit to restructuring expense on the income statement a huge hit to net income and a credit to the restructuring liability establishing the liability for 10 539 okay so that is what you do when when the board approves a restructuring plan you record the expense next we're in 2017 and in 2017 the company is actually thinking that they're going to need to incur more restructuring charges so they looked at their initial plan and they thought you know that's not really enough to cover all the costs that we're going to have we think we're going to have to spend another 3 million one hundred eighty nine thousand dollars okay so we need to increase the liability we again have to charge more expense so debit restructuring expense and credit the restructuring liability for thirty one eighty nine so they're increasing so now they've total restructuring expense of around 13 million dollars a little more than that and they've got a big total structuring liability of 13 million dollars as well okay now we're going to get to the point where we're paying off the liability so now they're paying you know they're paying severance they're uh you know whatever the costs are that they're incurring in this restructuring activity they're paying it and so there let's just assume that they're paying all this well yeah it says cash paid so cash paid and so cash is going to be involved in this next journal entry it's cash leaving the business so it's going to be a credit to cash and the debit is to the restructuring liability so they're paying off this obligation as soon as they make these payments they no longer have the obligation so that's why they're debiting the liability removing it from their balance sheet okay and finally there was non-cash reductions of 17 i don't know what the heck that is i know it was a credit to the restructuring liability because it increases the liability but i don't know what would be on the debit side of that and i don't really care because i consider seventeen thousand dollars to be immaterial when thinking about gopros operations so seventeen thousand dollars uh i'm fine with not exactly knowing what that is although i'm sure you could go into their footnotes and maybe learn more about what that is i'm not going to because it's not worth my time to investigate such a small dollar amount for gopro okay so that's how the journal entries uh work for restructuring remember when a board enters into a restructuring plan you record expense immediately and set up the liability then you adjust and pay down the liability in subsequent periods now i'll show you a piece of academic research that involves restructuring activities and this is from the journal of accounting in economics and it's from 2020 so it was just published the paper is called implication of non-gaap earnings for real activities and accounting choices and it's authored by yours truly and so that's why i'm bringing this paper up to you this was my dissertation that i wrote and it has to do with non-gaap earnings and let me just say a word about non-gaap earnings net income so you're familiar with the term net income that's at the bottom of an income statement another word for net income is gaap earnings okay gaap is generally accepted accounting principles and earnings means net income so net income is what earnings is if you use all of the accounting rules appropriately and you come to this comparable consistent definition of net income non-gaap earnings is something almost all public companies now disclose in their earnings announcements they make adjustments to gaap net income and what they're what they're saying is these accounting rules is producing these accounting rules are producing a distorted look at our operating performance and so we need to take certain expenses out of net income and adjust it in certain ways to make net income into a better performance measure and when they do that they come up with a new performance measure and it's called non-gaap earnings and it doesn't have any specific definitions companies can define it in many different ways you know in almost any way that they want to so this whole concept is called non-gaap earnings when companies adjust net income and present this alternative definition of earnings and what my dissertation was on was when you report a non-gaap earnings metric how does that affect your behavior so i know when i was an undergrad at the university of colorado so i went to the lead school of business as an undergrad and master's student when we were going out to get jobs and i was trying to get a job at a public accounting firm on my resume i had my gpa for the university of colorado and that was on my transcript my total university gpa but it was also common practice to report the business school gpa as a separate number so maybe you took some pretty hard courses in the university but you just want your future employers to know how good you are at business specifically so you would report a non-gaap gpa number of just your business school gpa stripping out all of the non-business classes like i took a lot of physics and astronomy classes in um undergrad and most people you know most of the time you'll get worse grade in physics class than you would in a business class and so if you strip those uh courses out of your gpa you can present a higher gpa and this is a non-gaap metric i mean you know this is similar to a non-gaap metric where the gaap metric is just the university transcript gpa right that's official but the non-gaap metric is adjusting it taking out my non-business classes and presenting my business only gpa okay so why am i talking about this well what effect does that have on my behavior in my non-business classes am i expecting to work as hard in those classes probably not if i think employers are going to be evaluating me on my business school gpa i have less of an incentive to work hard in my non-business school classes so that's the effect that presenting a different performance measure might have on my actual behavior and then the other thing i argued is that you might you might also be less likely to cheat in your non-business school classes you know if the if the business school gpa is what you care about maybe you'll be less likely to cheat in your non-business school classes so that's those are kind of hypotheses i investigated only in terms of non-gaap earnings and specifically i looked at restructuring expenses okay that's one of the things i looked at restructuring expenses are terrible they really hurt net income in the year that a company enters into a restructuring uh plan and so companies my hypothesis was companies don't really want to do it because they don't really want to take this huge hit to net income in the year that the restructuring plan is adopted okay so that huge expense is making companies not want to do restructurings that's the basic idea the key with non-gaap is that almost all companies that report non-gaap earnings exclude those restructuring expenses when calculating non-gaap earnings in other words they present net income on their gaap income statement but the non-gaap earnings that they're really trying to show investors excludes those restructuring costs okay so they don't really and my hypothesis is well if they do that then they probably are more willing to engage in restructuring activities because they'll uh they don't care that restructuring expenses have a huge effect on gap net income because it doesn't really affect their non-gaap earnings they're fine with it okay so that was my basic um hypothesis and so let me just show you one plot from the paper and that centers around a rule change so there was a rule change in 2009 called spaz 141r and this affected how you recognize restructuring expenses when you do an acquisition so when a company acquires another company typically they'll restructure that other company when they acquire it and um so the rule change involved how to expense those costs and so prior to 2009 when you a when a company acquired another company and then engaged in restructuring activities those restructuring costs didn't have to be expensed so it was a little bit different treatment if you incurred restructuring costs in a business acquisition you could capitalize those restructuring costs into the purchase price of the business okay so you're when i'm when i say capitalize i mean it goes on your balance sheet you debit an asset account you do not debit an expense account like restructuring expense so before 2009 when you were in when you were doing an acquisition those restructuring expenses could stay off your income statement okay you so nobody really cared about the restructuring affecting net income before 2009 because it didn't affect net income before 2009. after 2009 uh the fasb changed their mind and they said well just because it's an acquisition doesn't mean you should treat restructuring costs any differently so now going forward when you incur restructuring costs in an acquisition those have to be expensed just like all the other restructuring costs so after 2009 if you do an acquisition and you do restructuring costs well now it is going to affect your net income and so now companies are not again they're not going to want to do these restructuring activities so that's why i investigated and the uh the black line uh represent so what is this plot showing you the the y-axis here is the percent of acquisitions that involve layoffs so i got a sample of acquisitions and then i uh have a data set of whether a layoff occurred at that company and so before 2009 and let's just average here 35 of acquisitions involved some sort of a layoff at the acquiring company okay so 35 percent of the time when a company acquires another company they'll do a layoff and that's before 2009. after 2009 you can see the percentage of acquisitions involving layoffs declined dramatically and you might attribute that to a um to the financial crisis maybe um but the the amount of layoffs declined dramatically why what is one reason for that decline well now when you do a layoff after after an acquisition you have to charge that expense to net income and so companies you know when they do acquisitions they're less likely to do restructuring activities after 2009 because they don't want those expenses hitting net income what i did is i tested for a difference between non-gaap and gaap reporting firms so the red line is firms that just report gap net income they don't report any non-cap earnings the black line are firms that report non-gaap earnings and the effect i calculated there's a difference in difference here where the effect of this rule change was stronger on the companies that report gap earnings than it was on the companies that uh report gaap and non-gaap earnings so the companies that report non-gaap in other in simple terms the companies that reported non-gaap earnings were less concerned about this rule change because the primary performance measure that they were focused on was non-gaap earnings and that excluded restructuring costs whether it was before or after the rule change they don't care about restructuring costs whereas these red companies just report gaap net income they don't report any gap earnings so when this rule change happened it really affected their primary performance measure which was gap earnings okay that was long-winded uh but i'm always happy to um be able to have a topic which i've actually done some research on you know it kind of combines the two things that i do in this job so that's all i wanted to go through with you uh the first part was uh you know how to account for restructuring costs and the second part was uh just one piece of academic research on restructuring costs and how they affect firm behavior so i hope you enjoyed that one and i'll talk to you later bye bye